INSURANCE AND

RISK

Group 1
fm22fb1
LEARNING OBJECTIVES

After studying this chapter, you should be able to:

▪ Explain the basic characteristics of insurance.
▪ Explain the law of large numbers.
▪ Describe the characteristics of an ideally insurable risk
from the viewpoint of a private insurer.
▪ Identify the major insurable and uninsurable risks in
our society.
▪ Describe the major types of insurance.
▪ Explain the social benefits and social costs of insurance. 2
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DEFINITION AND
CHARACTERISTICS

BLYTHE AMADAR
Definition of Insurance

▪ The pooling of fortuitous losses by transfer of such

risks to insurers, who agree to indemnify insured for
such losses, to provide other pecuniary benefits on their
occurrence, or to render services connected with the
risk.

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Basic Characteristics of Insurance

Based on the preceding definition, an insurance

plan or arrangement typically includes the
following characteristics:
▪ Pooling of losses
▪ Payment of fortuitous losses
▪ Risk transfer
▪ Indemnification 5
Pooling of Losses

Pooling is the spreading of losses incurred by the

few over the entire group, so that in the process,
average loss is substituted for actual loss.

Pooling involves the grouping of a large number of

exposure units so that the law of large numbers can
operate to provide a substantially accurate prediction
of future losses.
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Pooling of Losses

The law of large numbers states that the greater the

number of exposures, the more closely will the actual
results approach the probable results that are
expected from an infinite number of exposures.
▫ Thus, pooling implies (1) the sharing of losses by
the entire group and (2) prediction of future
losses with some accuracy based on the law of
large numbers.
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Payment of Fortuitous Losses

A second characteristic of private insurance

is the payment of fortuitous losses.
• Fortuitous loss is one that is unforeseen
and unexpected by the insured and occurs
as a result of chance. In other words, the
loss must be accidental.
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Payment of Fortuitous Losses

• The law of large numbers is based on the

assumption that losses are accidental and
occur randomly. (For example, a person
may slip on an icy sidewalk and break a leg.
The loss would be fortuitous.)

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Risk Transfer

• Risk transfer is another essential element of

insurance. With the exception of self-insurance, a
true insurance plan always involves risk transfer.
From the viewpoint of the individual, pure risks that are typically
transferred to insurers include the risk of premature death,
excessive longevity, poor health, disability, destruction and theft of
property, and personal liability lawsuits.

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Indemnification

A final characteristic of insurance is

indemnification for losses.
• Indemnification means that the insured is
restored to his or her approximate financial
position prior to the occurrence of the loss.

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 2

BENEFITS OF INSURANCE
TO SOCIETY

Guillian asantor
 CHARACTERISTICS OF AN IDEALLY
INSURABLE RISK
▪ There must be a large number of exposure units.
▪ The loss must be accidental and unintentional.
▪ The loss must be determinable and measurable.
▪ The loss should not be catastrophic.
▪ The chance of loss must be calculable.
▪ The premium must be economically feasible.

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 CHARACTERISTICS OF AN IDEALLY
INSURABLE RISK
1. LARGE NUMBER OF EXPOSURE UNITS
- there should be a large group of roughly
similar, but not necessarily identical, exposure
units that are subject to the same peril or
group of perils.
2. ACCIDENTAL AND UNINTENTIONAL LOSS
- the loss should be unforeseen and unexpected
by the insured and outside of the insured’s
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control.
 CHARACTERISTICS OF AN IDEALLY
INSURABLE RISK
3. DETERMINABLE AND MEASURABLE LOSS
- the loss should be definite as to cause, time,
place, and amount.
4. NO CATASTROPHIC LOSS
- a large proportion of exposure units should
not incur losses at the same time.

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 CHARACTERISTICS OF AN IDEALLY
INSURABLE RISK
5. CALCULABLE CHANCE OF LOSS
- The insurer must be able to calculate both
the average frequency and the average
severity of future losses with some accuracy.
6. ECONOMICALLY FEASIBLE PREMIUM
- The insured must be able to afford the
premium.
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TWO APPLICATIONS:
THE RISKS OF FIRE AND
UNEMPLOYMENT
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ADVERSE SELECTION
AND INSURANCE

ELIZABETH BERNALES
Adverse selection

• is the tendency of persons with a higher-than-

average chance of loss to seek insurance at
standard (average) rates, which if not controlled
by underwriting, results in higher-than-
expected loss levels.

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Underwriting

• refers to the process of selecting and

classifying applicants for insurance.

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Adverse selection

Policy provisions are

also used to control
adverse selection
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“ INSURANCE AND
GAMBLING COMPARED
▪ First, gambling creates a new
speculative risk, while insurance is a
technique for handling an already
existing pure risk
▪ The second difference is that
gambling can be socially
unproductive, because the winner’s
gain comes at the expense of the
loser.
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“ INSURANCE AND HEDGING
COMPARED
▪ First, an insurance transaction
typically involves the transfer of pure
risks because the characteristics of
an insurable risk generally can be
met
▪ A second difference between
insurance and hedging is that
insurance can reduce the objective
risk of an insurer by application of
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the law of large numbers
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TYPES OF INSURANCE

Flora mae astudillo

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Major Types of Insurance

1. Private Insurance
- Life and health insurance
- Property and liability insurance

2. Government Insurance
- Social Insurance
- Other Government Insurance
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Major Types of Insurance

1. Private Insurance
Life and Health Insurance - pays death benefits to designated
beneficiaries when the insured dies.
Property and Liability Insurance (Property and Casualty
Insurance)
Property Insurance - indemnifies property owners
against the loss or damage of real or personal property caused
by various perils.
Liability Insurance – covers the insured’s legal liability
arising out of property damage or bodily injury to others, legal 29

defense cost are also paid.

Major Types of Insurance

Property and Liability Insurance

1. Personal Lines – refers to coverage that ensure the
real estate and personal property of individuals and
families or provide protection against legal liability.
 Private passenger auto insurance - protects the
insured against legal liability arising out of auto
accidents that cause property damage or bodily injury
to others.
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Major Types of Insurance

2. Commercial Lines – refers to property and casualty

coverages for business firms, nonprofit organizations, and
government agencies.
Fire and allied lines insurance
Commercial multiple peril insurance
General liability insurance
Workers compensation insurance
Commercial auto insurance
Accident and health insurance 31
Major Types of Insurance

Inland marine and ocean marine insurance

Professional liability insurance
Equipment breakdown insurance ( boiler and
machinery insurance )
Fidelity and surety bonds
Crime insurance
Other miscellaneous lines
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Major Types of Insurance
2. Government Insurance
Social Insurance - are government programs with certain
characteristics that distinguish them from other government
insurance plans.
 Old -age ,Survivors, and Disability Insurance ( Social
Security program )
 Unemployment insurance
 Compulsory temporary disability insurance
 Railroad retirement act
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 Railroad unemployment insurance act
Major Types of Insurance

Other Government Insurance - other government

programs exist at both the federal and state level.
Federal Insurance programs:
 Federal employees retirement system
 Civil service retirement system
 Life insurance programs ( veterans, pension
termination insurance, insurance on checking and
savings account )
 Federal flood insurance 34
 Federal crop insurance
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BENEFITS OF INSURANCE
TO SOCIETY

TRISHIA BAUTISTA
“ ▪ Indemnification for loss
▪ Reduction of worry and
fear
▪ Source of investment
funds
▪ Loss prevention
▪ Enhancement of credit
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INDEMNIFICATION FOR LOSS

1. Indemnification permits individuals and families

to be restored to their former financial position
after a loss occurs.

2. Indemnification to business firms also permits

firms to remain in business and employees to
keep their jobs.

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REDUCTION OF WORRY AND FEAR

▪ Families are less likely to worry about the financial

security of their dependents in case of premature
death
▪ Property owners enjoy greater peace of mind
▪ The insureds know that they have insurance to pay
for the loss

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SOURCE OF INVESTMENT FUNDS

1. The insurance industry is an important source of

funds for capital investment and accumulation
 Premiums are collected in advance of the loss
 Increases society’s stock of capital goods
 Promotes economic growth and full
employment

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LOSS PREVENTION

Important loss-prevention activities that property and

casualty insurers support the following:
 Highway safety and reduction of auto accidents
and deaths
 Fire prevention
 Reduction of work-related injuries and disease

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LOSS PREVENTION

 Prevention of auto thefts

 Prevention and detection of arson losses
 Prevention of defective products that could injure
the user
 Prevention of boiler explosions
 Educational programs on loss prevention
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ENHANCEMENT OF CREDIT

A final benefit is that insurance enhances a person’s

credit through the following:
• Guarantees the value of the borrower’s collateral
• Gives greater assurance that the loan will be repaid
• Protects the lender’s financial interest if a property is
damaged or destroyed

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COSTS OF INSURANCE
TO SOCIETY
“ ▪ Cost of doing business
▪ Fraudulent claims
▪ Inflated claims

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COST OF DOING BUSINESS

• Insurers consume scarce economic resources

• An expense loading must be added to the pure
premium to cover expenses incurred by insurance
companies
- Amount needed to pay all expenses, including
commissions, general administrative expenses,
state premium taxes, acquisition expenses, and
allowance for contingencies and profit
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FRAUDULENT CLAIMS

• Auto accidents are faked or staged to collect benefits

• Dishonest claimants fake slip-and-fall accidents
• Phony burglaries, thefts, or acts of vandalism are reported
to insurers
• False health insurance claims are submitted to collect
benefits
• Dishonest policyholders take out life insurance policies on
unsuspecting insureds and later arrange to have them killed
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INFLATED CLAIMS

The dollar amount of the claim may exceed the actual

financial loss. Examples of inflated claims are the
following:
• Attorneys for plaintiffs sue for high-liability judgments
that exceed the true economic loss of the victim
• Insured inflates the amount of damage in auto collision
claims so that the insurance payments will cover the
collision deductible
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INFLATED CLAIMS

▪ Disabled persons often malinger to collect

disability income benefits for a longer duration
▪ Insureds exaggerate the amount and value of
property stolen from a home or business

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THANK YOU FOR
LISTENING!
GROUP 1
AMADAR
ASANTOR
ASTUDILLO
BAUTISTA
49
BERNALES